RH (RH) 2016 Q3 法說會逐字稿

Good afternoon, my name is Ian and I'll be your conference operator today. At this time I would like to welcome everyone to the RH third-quarter FY16 Q&A conference call.

(Operator Instructions)

I would now like to turn the call over to Ms. Cammeron McLaughlin. Please begin.

Thank you, good afternoon, everyone. Thank you for joining us for RH's third-quarter FY16 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, and Karen Boone, Co-president and Chief Financial and Administrative Officer.

Prior to this call we posted a video presentation to our Investor Relations web site, IR.RestorationHardware.com, highlighting the company's continued evolution and recent performance.

Before we start, I'd like to remind you of our legal disclaimer that we will make certain statements that are forward-looking within the meaning of the federal securities law, including statements about the outlook for our business and other matters referenced in our press release and video presentation issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially.

Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results any of revision to these forward-looking statements in light of new information or future events.

Also during our call today, we may discuss non-GAAP financial measures which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the Investors Relation section of our web site at IR.RestorationHardware.com.

With that I'll turn it over to the operator to take our first question.

(Operator Instructions)

Matt Fassler, Goldman Sachs.

Thanks a lot and good afternoon, good evening. My question really relates to underlying demand as best you can address it. You said in the video that written sales are not quite up to expectations in the third quarter and certainly that was the case it sounds like in November. If you could talk about the cadence of demand and the impact that some discrete items might have had on it, specifically your discussion of the later mailing of the books, and also the weakness that you had in November, and perhaps what you've seen in the brief couple of weeks since then?

Sure. Matt, this is Gary. There's really three things we can look at and somewhat quantify today, and that is there's a real softness in November. November got off to a very slow start. We think that was created by some distraction around the election. At least that was our hope early on. As we got past the election, our business was building at a slower rate than we had anticipated, and as we dug into, looked at some of the implications around that, one of the things that stood out was our books were getting in home slower in November specifically than we had planned. So beginning in November, we lost about a month of books in the delay.

And also impacting the businesses is really just a poor performing holiday collection, and we believe some of that in looking back, is from probably being too aggressive and pulling too much of the holiday content out of the store. Our thesis was we could consolidate holiday from the DC, consolidate the inventory in the DC, move more of the sales to direct, offer free shipping, and we could run the business at a more productive level and at a higher margin. And our thesis, it proved to be incorrect. I think we're just losing too much of the conversion from the store traffic in the store. So one of the things we're considering is next year, [layering] back in some of the holiday decor and gift items that we won't put the stocking stuffers back in. We think that's a legacy business that doesn't associate with our business, with our current content. But that's really the key things.

For us right now, I think what's difficult is as we sit here today, how do we think the business will build into January, and how do we think the business will build as the books get in, and also as the impact of our kind of gallery conversions and remodels where we put Modern and Design Ateliers, how long is that ramp? In New York, when we converted that store and watched Modern last year, it took about six to eight weeks to build to the level, where Modern built to a level where it was doing consistent run rate. And so it took about that long, so we think we've got probably, we've got a build coming from the investment we made in the stores, we've got a build coming from the books in home at a month later versus where we are. And then the holiday miss is going to go away, right? So at the end of the month, the holiday miss, the drag of the holiday reduces considerably. You have some holiday markdown sales in the first few weeks that are a little bit of volume, but then it falls completely off.

So as we look forward in the next year, and we rebuild our base off of next year, off of where we think this will land, and I think I characterized, I think we're being conservative, and in Q4 today, because we just don't have visibility in the builds, right? It could be a little better, but today, based on where we sit, we thought it was right to take a conservative view based on how we saw the rest of the December and January. But when you build and you look forward and you take a look at next year, and you build off the base where we think we're going to end, and you take a look at the four revenue and earnings drivers next year as you look forward to 2017, we're going to anniversary of the cost related to the launch of RH Modern, which we've estimated around $20 million. We moved beyond the timing issues related to the launch of RH Membership and expect membership revenues and earnings to increase by about $20 million year over year, and that's on the P&L affected, right? So we'll pick up about $20 million there. And those fall straight to the bottom line, right, those are 100% margin.

And then we'll begin to cycle the efforts to reduce our inventory and rationalize our SKU count, and so we expect product margins to rebound meaningfully year over year beginning in the first quarter. And then the fourth point, which is the one that we'll have to watch as we build through the end of this quarter, and into first quarter, but we expect revenues to increase based on the fact that we just mailed the books, and we'll be up against no source book throughout the first three and a half quarters of next year, right, and then we'll mail the Modern book in the first quarter. So that should provide substantial revenue lift year over year, and you add to that new stores that are flowing from this year into next year, and you add the new stores that we're opening next year.

So we feel very good about looking at how we see 2017, and what I mentioned in the video. With each passing quarter, we have more certainty as it relates to how we look at 2017. We have a lot of data now about membership. The only open issue I'd say about membership that we don't know next year, but I think we're conservatively forecasting it, is how we're forecasting renewals, right? But we do know from signups today, that a very minimal percentage are opting out, saying don't auto renew me, so we believe based on what we've studied in other companies and what we think renewal rates will be, we think we're conservative, and we've got that forecasted in at a conservative rate. So we have a lot of data now. We feel very good about how memberships are rolling through. And as we think about 2017, we think we're going to bridge into next year, and be very happy with where we land.

I guess a brief follow up just to get clarity, are you getting any comfort from the build that you've seen, since business presumably troughed around the election. Is it driving closer to a rate that would be consistent with your launch in growth expectations? Or is it still subdued given the holiday issues and the mailing of the catalog, the timing of the mailing?

It's clearly subdued and we forecasted it to be subdued from a demand and revenue point of view through the rest of the quarter. My point being is if you take that new base, right, and you build off the base into next year, we feel very good about what next year looks like, and the bridge back to business performance that would be more in line with what we'd expect.

Thank you.

Oliver Chen, Cowen and Company.

Hello, thank you. I had a question regarding the SKU rationalization. So why did you guys pursue a it little more aggressively than you originally expected? And also on the CapEx line, do you have flexibility to continue to tweak that number down in the event that your free cash flow doesn't materialize how you'd like it to?

And Gary, I think you articulated this, but if you could have done this over, over the past year, just what would you have highlighted that, some differences you would have made? And I think also we wanted to know about the source book, why was it a little bit later? You had mentioned that it was one month later than planned. Thank you.

Sure. Let me address those from bottom to top. I'm going to take it backwards, but why the books and later than planned. One, we're one of the few people that mail a book our size and in our complexity. Some of our books are mailed in bundles. We mail 600-page books. Our printers don't really have other books of that size besides phone books, right, so our books don't go through like a typical catalog goes through a facility, and our book goes through multiple facilities. So there's always a chance that there's going to be some delay in the printer, which we had some delays. Likewise, when you go through the US mail postage system with a book of our size, at each of the books that -- each of the points that it moves through, whether it's going from the printer [to DMC] or an SCF, special center facility, and then breaks out to a post office, and then the post office's ability to handle it and move it, our books can be somewhat imperfect in predicting how they move through all those points and all those steps.

So we had some delays as we moved through the printers, and we had delays as we moved through the postal network, and those delays were compounded in the postal network, and we didn't anticipate. It's the first time we've mailed and had books going in, in November and in December. So the November books is where we missed, and I think we missed because we went into a very crowded time, right, so you have all the holiday mailings.

And the other point is, you had, it was very unusual, we had all the postage that was going through based on the election, right, so if you think about early November, a lot of election postage going through the pipeline. So that's the feedback and the insights we've been able to give. So that's the impact as it relates to the book being later by about, we lost about a month of in home, about 30 days of in home.

What would I do over? But clearly we decided to use this year as kind of a transformational and transition year, and take a lot of, make a lot of moves with the business, moving from a promotional model to a membership model which we thought was right for the business long term. We clearly, in the first quarter, we were still in the very early days of the launch of RH Modern, and so we had to figure out how to ramp that business. We decided to reevaluate our supply chain and the way we were moving against our supply chain, and we were ready to put a shovel in the ground to build another DC. We decided not to.

One of the ways to avoid that was to reevaluate our inventory, be more aggressive in moving through SKUs that were not long term that we didn't think hit the performance hurdles and metrics to be in the assortment, so we decided to accelerate that this year, avoid building a distribution center, give ourselves time to reevaluate the network, and design the supply chain network in a way we thought could be more productive and more impactful to capital usage and [turns], long term. And as far as several other initiatives, right? We redesigned the entire source book, and to do that we delayed that. And also we delayed it to give our vendors more time to catch up on Modern. We remodeled all of our stores, rolled out Design Ateliers and doubled the size of our interior design team.

So when I look back at many of those things, and there's some other things we did too, but those are the big ones. And I say to myself what would I have done different this year? The biggest thing, if I had to make a decision over again, I would not have delayed the source book. I think the vendors in Modern recovered and caught up. I don't think that mailing the source book would have had the impact we thought it could've, the risks we thought it could have on the vendor base. And the efforts to redesign the source book, while I think it looks fresh, new, and very impactful, the lost sales of mailing it six to eight months later, right, cost us significant revenues and earnings. I think that created the biggest risk on the year. So that's what I would have done over.

Then Oliver, on -- any follow ups on that one? I can take the other two.

Karen, I was curious for investors who are concerned about free cash flow and the outlook there, it would be great to be briefed on your thoughts around that CapEx. And strategically, the SKU rationalization was, why were you incrementally more aggressive? Was that an effort just to make sure you were clean? Because it looks like you've been prudent about trying to make sure you're aggressively managing inventories as well.

Yes, so the two questions are definitely tied, because they both impact our free cash flow. One, our working capital has been something that we're very interested in making sure that those inventories get down, as you guys saw. We ended last year with our Q4 miss with much higher inventories that we wanted. So some of that, the ongoing assortment, we just managed through lower receipts, but there were that critical evaluation of the SKUs, as Gary mentioned, to see what we no longer needed in the assortment.

So we've been making great progress in that initiative. As you can see at the end of Q3, our inventory was at plus 2, and that includes the Waterworks, so really great progress with that. But as we're heading into Q4 with some of the slow down and what we saw in November, whether it was the election or the consumer, whatever the reason, we don't want to be sitting on some of that inventory, and we want to move through it. So we went to, at the beginning of the month or about the 11th, we went to 20% off sale. A lot of the stuff that's on sale is that SKU [rat] merchandise.

And then we also just took a little bit deeper markdowns on some of that. We're planning to continue to do that through the end of the quarter just to make sure we're clean by year end, and do get through what we wanted to get through. So that has obviously a very positive impact on our cash flow situation as we head into next year, if we can continue to make improvements on getting our inventories down.

The second piece of that was the capital. You saw that we took our range down, that's really just based on the lower sales and what we're looking at. We're taking a much more critical look at what projects we have on deck, what's in flight, where do we need to be more critical in that spend. I still feel really confident in what we have the ability to effect, both in the real estate and other projects, what's nice to have, what a need to have; and we'll continue to be diligent in that to make sure we reach and deliver that free cash flow positive goal in 2017.

Okay, thank you, best regards.

Steven Forbes, Guggenheim Securities.

Good evening. Gary, if you can, maybe just taking a step back, given the amount of challenges this year and recent additions to the team, can you just give your thoughts on the organizational capacity of the business, given everything that's going on as we look out into 2017 and beyond here?

Sure, yes, I think we have the strongest team we've ever had historically. I think especially the -- let me start at the top. I think the changes we made in creating the office of the president to drive, break down silos, drive collaboration, drive across functional view of the business, as we drive our key strategies and priorities and decision making through the company. I think it's just beginning to make a very big impact, and I think when I look back at my career years from now, my sense is I'm going to look back and say that's one of the best business decisions I've ever made.

Because the silos that are being broken down, and the collaborations that are happening, and the way we're now starting to lead and make decisions for the future, I think are just significantly better decisions, more fully informed. And we're going to start seeing impact, benefits from that as we look into next year.

So that is also trickling down to how we've organized the organization at a level below, right, so we've created internal chief merchandising officers inside the business. We have three of them. They control cross functional teams that have merchandising, product development, sourcing, inventory management, where many of those functions were independent. And again, breaking down those silos and the leadership, the leaders we have there, I think are fantastic, and we're going to see big impact from the business there.

And I think the next big piece is really what DeMonty has done with in a very short period of time in the supply chain operations, call center part of the business. And if the organization that he's put in place, and the strategies they're developing, the urgency they have, the fresh minds and points of view looking at our supply chain, and looking at our product pipeline, and how we lead that, and how we execute at that level, I think is the impact that we're going to see over the next one, two, and three years, I think is going to be huge. Alex has brought in tremendous talent. Tom [Kurtz] worked with Alex at Amazon. Tom was the head of global customer service for Nike, and Alex brought him into the company. Dave Newman who was at Target and crossed paths, worked with Alex at Target, and then part of that was at Apple in supply chain and operations and technology who's joined us at senior level is terrific. And these three guys have worked together and they understand each other, and I think they have just standard levels that are much higher than we've ever had, and intellect in problem solving capability that is world class.

So I just couldn't be more excited about the team and the changes that DP, DP is DeMonty, excuse me, that DeMonty has made. And there's many other changes. DeMonty likes to say he's also our Chief Values Officer, and one of the things you hear him say almost every day is, the right people are our greatest asset and the wrong people are our greatest liability. And he's made, I think, 54 changes in that organization, and the people that he and Alex and team have been bringing in, I think we're going to see some leapfrogs. I think we're going to see that organizational leapfrog over the next one, two, three years.

So couldn't be more excited about what's happened on this side of the business, and I think just across the organization, I think this is the best team we've ever had. And of course our results, right now I'm talking about this in the face of kind of a very disappointing outlook as we've just guided it down, but I think, look, we made some very brave and courageous decisions this year that I think are significantly strategic that many people don't make in our industry. And I think that we're going to be right on most of them.

And I think that the one thing, if I had back, if I could have done it over, if we would have mailed the book in the spring, we'd have probably had a hundred million dollars more in revenue this year, and the earnings outlook would have looked a lot better. But we thought we had enough room to navigate. We thought we wanted to get the book redesigned and give our vendors some room. Again if I had that one to do over again, I would have done that one over.

But based on the data we have today on Memberships, based on how RH Modern is building and tracking, based on how our new galleries are performing, based on how F&B has performed in Chicago, and our investments to build an F&B organization and put restaurants, wine vaults, and coffee bars in five stores next year, and the impact we think that'll make to the long term model of the business, and the remodels of all of our galleries and putting Modern in the stores and putting Design Ateliers and investments in interior designers, I think they're all the right strategic investments.

And I think the decision to go through an aggressive SKU rationalization, and forego building another furniture DC, and rethink how we're going to design the supply chain network; and most likely have a strategy that has fewer DCs that require significantly less working capital and inventory, and is going to improve in stocks, and the things we're doing, the investments we're making, and the final mile system in selectively insourcing delivery and trucks and the tests we have there, I think it's going to make a huge impact on the back end of our business and customer experience. So I like our team, and I like our strategy, and as you guys saw earlier in the quarter, I am too, an investor.

Thank you, Gary. And then maybe as a follow up, kind of touching on one of the topics you mentioned there, pertaining to home delivery and the progress you're making on those initiatives, can you touch on where you are today, both in terms of your customer satisfaction scores with delivery in general? And also, Gary, if you can, where does the company sit today versus where it needs to be as it relates to completing that final mile and completing the transaction itself?

Yes, I think as you look across our supply chain, there's some areas where we're executing at a B, and some areas we're executing at a C level, and we believe we can leapfrog and get everything to an A level. And it's going to be kind of a step by step as we make these investments. We've got a lot of things that we've got to test. We're moving in the Bay Area and DC. We're buying our own trucks or leasing or own trucks, we're end sourcing it, we're taking 100% control of the delivery. We just think there's an enormous opportunity here to reduce returns, reduce exchanges, get deliveries to stick, delight customers at that point.

And I think I said it before, the fact that we have outsourced that last piece of the business, and it's really been a compounding outsource, right, many markets where we don't control or we haven't controlled the hub. We're starting to take more control of the hub, but we don't control the delivery, right. So you have a third party kind of delivery group who's scheduling drivers. Those drivers are not always consistent. There's an inconsistency in the vehicle. There's an inconsistency in the talent and the people that are making the deliveries.

And if you can make a justification at actually going to the people's homes with a third party, and in some cases it's a third party's third party. It's a double outsource, compounding outsource situation. Just because it's slightly cheaper you should make the same argument and say why don't we staff our galleries with third party people, and stuff like that. I'm sure we could do it cheaper.

But it's not the brand we're trying to build. I think we still have a some kind of legacy habits, right, and mind set left. If you think about what this brand used to be, and the brand we've built today. If you look at the go forward expression of this brand, and you look at the galleries in Los Angeles, Atlanta, Chicago, any of the new ones we've opened, this is a world class experience. No one's ever built retail experiences like this. The level of the quality of the product, the level of the quality of the experience, the level of the quality now that we're taking the interior design to.

You've got to have a consistent quality level throughout a brand, right? The great brands don't have different levels of quality at different customer interaction points or touch points or -- and the really great brands, it's a consistent level of quality. And I think because we've taken this company and this brand from something very different to kind of where we are, we still have parts of the business that are catching up, right? And that's where we're making investments and where there's a lot of upside.

So we, again, listen, the good news is we're not sitting here thinking that there's not a lot that we can do better. We think there's a ton we can do better here. And that's why we're making the changes that we're making and making the bets that we're making.

And the other thing I think that, I wouldn't let it get lost on anyone, moving from a promotional retail model to a membership model, creating a more consistent streamlined business, the impact that's going to have on our execution, on our cost structure, on our ability to think strategically, and make important decisions for the business, as opposed to how most retail companies with promotional cadence, their week to week, spending all their time to trying to figure out what's the next sale, what's the next promotion, how do you comp this, how do you comp that, and you get a much lower level kind of thought process, right?

And I think what's different about us is, we think big. We make big moves. We make big strategic moves. That's how we've gotten to where we are. We're at the very early stages of doing a real estate transformation that the world's never seen. We've already augmented that with hospitality in a manner that the world's never seen. We've just introduced RH Modern with a 500-page book which is a meaningful business and opened a brand new store. We are taking interior design services to a level that the industry has never seen.

And I think it's because we have the ability to think strategically, to see big moves. We wanted to get out of the rat race of this crazy promotional cadence of having the same e-mails that everybody has, the same -- how many companies over the last two months have mailed you a friends and family sale, a president or private sale message, only for you sale, like -- you name it, right? It's a mess out there, and I think, look, does the mess work to a degree? Sure it does. Is there a better way? We absolutely think so.

And when we think once we -- we said early on at the beginning of this year, this leadership team stood together, and we said, do we have the courage it takes to march into hell for a heavenly cause? We created a strategy and a view and our numbers said, yes, it was going to be a difficult year, but when we get on the other side of this, this new model is going to be long term significantly more productive, we're going to spend our time in a much more strategic way, and we're going to operate a different kind of company. And like I said to team, it's really hot right now, right? We're still in the middle of hell, but we're a few steps away from the other side. And I think you're going to see, when we get to the other side, the next five to ten years I wouldn't want to be competing against us.

Thank you.

Adam Sindler, Deutsche Bank.

Yes, hello, good evening, everyone. I was hoping to ask maybe a couple of bigger picture questions here. I think on the call maybe four or five times you've talked about transitional year, 54 changes that DeMonty Price made, big strategic moves, the bars and the interior design. And then you're looking back at 2014, and maybe in 2013, there's a lot of redesign to the full line galleries, and clearly all those things are exceptionally important, right? They're being flowed through to the new model. But at what point do you think it would be prudent to maybe try and lock in some sort of strategy? Just to not have pieces moving around so much? Because as you become a big organization, those changes are magnified, would be the first, sort of bigger picture

And then second bigger picture, on the SKU rationalization, I was under the impression that the whole reason of having a very broad line was to have a very long tail to the product life, such that new product is not to simply replace product, but to actually introduce newness. And then sort of balance that against $0.40 to $0.45 of inventory production charges.

Well, one, we do have a wide and dominant assortment, and we'll have a wide and dominant assortment, I think, at the high end of the luxury end, I think we have no peer, right? The question we get a lot is, who are your competitors, right, nationally? And I think the fact that nobody can really name very many of them is because we have an assortment that really doesn't exist in the marketplace anywhere else, at our dominance and depth and breadth.

But that doesn't mean that you shouldn't go through a SKU rat, that doesn't mean after five, six years of really, we had four straight years of comparable brand growth that was over 25%, right? So you go through high growth years, and there's going to be some inefficiencies everywhere in your organization, and so we're trying to deal with those inefficiencies, whether it's in the supply chain, whether it's in the assortment, whether it's in what we think was a promotional cadence to the business that wasn't right for the brand long term, whether it's what the store size is, and whether it's like -- I don't know, you say like -- geez, when do you stop and lock in a strategy? The investor depth that we present hasn't really changed. The same slides, right? Who is the home brand for the luxury customer, right? That question frames our opportunity.

RH is building the most dominant assortment at the high end. We built a supply chain that offers tremendous value and is completely disruptive. Our real estate, the biggest value driving priorities in the company, which we've been saying for multiple years here, is the transformation of our real estate and the continued expansion of our product offer. So the launch of RH Teen last year, the launch of RH Modern last year, the launch of Hospitality, the testing, driving -- nobody knows how to drive traffic in retail. If you saw the video, that's what it looks like every Saturday and Sunday. Find another store that has them lined around the block. So if investors' expectations is that we had to stop innovating, I think you're betting on the wrong people here, because we're not going to stop.

But look, I think it's Simon Sinek that said, there's nothing efficient about innovation, and did we pack a lot of innovation into this year? We did. Did we decide to use this year to transform in a transitional way to do a lot of things? We did. And we told you that. Did we think that the numbers were going to be hard to predict? We did. Were they more hard to predict than we thought? They were. Does it mean that there's anything systemically broken here? I think if you listen to, if you watch our videos and listen to what we're saying, we're telling you there's not. You can choose to believe us or not, that's your choice.

But I'm also seeing they bought a lot of stock in this last quarter. So I didn't just do it for optics, 95% of my net worth is in this company. So yes, we feel really good about what we're doing. And is every year going to look like this year? Of course not. Have the last five years looked like this year? No. Is there going to be change and innovation every year? Of course there is. Unless you want us to be like a lot of other retailers. If you walk a retail mall, and I don't think most people know that at a retail shopping center, a retail mall is like a graveyard for short lived ideas. Does anybody know what percent of retailers live out the ten or twelve years of their lease? It's a very low percentage. How many retailers make it two lease terms? Go walk a mall. It's only the ones that innovate that are still here.

Okay, thank you, I appreciate that. And then secondly, in the video it talked about the doubling of revenues from the mall based stores to the full line stores. I know you said more than 2 times, but just in the past for clarity, it's been closer to 2 to 4 times. I wanted to make sure that 2 to 4 times is still the right outlook to use.

Yes, the way to think about it, when we use the Denver model, right? Back then we had a smaller assortment, we weren't impacted by Modern or Teen yet or a lot of SKU growth, so as we did all our real estate deals during that period, right, when we presented that, we had lower base volumes. So our expectation was to get a 2X to 4X, at that point somewhere around a 3X we thought was about the right number. Our average store volume since that point have grown from 8 million to 12 million in an average gallery.

So all our numbers that we thought -- if you looked at our business from then, every market that we said, we can go from here to there, the number there is still correct. It's just not a bigger base. So it may start at a 2X, it may start at 2.5X. But also I'd say with the layering on of Hospitality, that's incremental, and the extra business at Hospitality drives to the gallery, at least based on our first test, it gives us some expansion. I think what we're saying is we have at least a 2X lift to the retail sales in every market, right off a bigger base now.

That was perfect. Thank you, I appreciate it.

Peter Benedict from Baird.

Yes, hello, guys, thanks. Just a clarification, on the fourth quarter it looks like the implied CBR down high teens maybe. The top line acceleration you're thinking for next year, I know Karen you said up kind of each quarter. Does that mean CBR you think will be up in the first quarter? Or is it just total revenue is up and then CBR catches up later in the year?

Yes, I think we're at this point talking about total revenue. We are not --

We're not giving quarterly guidance yet.

We are not giving quarterly guidance yet on comps, but I will say that some of the things that are non comp right now that are making a pretty wide delta between total revenue and the brand comp, things like Waterworks, things like membership revenue, new stores -- new stores, we won't have -- there'll always be a number there. But some of the other things are going to go back into the comp base. We plan to put membership revenue in as soon as the anniversary of the launch, and then in May of next year is when we'll anniversary of the launch, or actually the acquisition, I should say, of Waterworks. So those are some of the big drivers that are pushing that delta further than normal, and it will shrink down the middle of next year.

Okay. That's helpful, thanks. And then on the membership program, it looks like at least over the last couple of quarters, so when you've had it for a full quarter, so 2Q, 3Q, you've been signing up maybe 7,000 to 8,000 members a week, at least that's been the pace. Is that the level we should be thinking about going forward in the 4th quarter? How are you thinking about the pace of signups from here?

Yes, it's ranged between anywhere from 5,000 to 8,000 a week, depending on the week, and depending on what's going on with our volume. I don't think that's going to change too much. It's generally pretty consistent with sales, as we said 90% of our volume is coming from members, so we don't expect that percentage to change, so it should just track with sales.

Okay. And just the last question around that, to the degree that you've been able to track it or look at it, can you comment on how the member has behaved, before you had the member program to the degree you had details about how they were spending with you? And then what their shopping habit has been since? I recognize it's not a long period of time, but any early thoughts on that?

The only thing I think we commented on is the average order is slightly bigger, and the time to transact is longer, right? So without the promotional kind of urgency dates that drove someone to, oh I better purchase this now, they're working through their interior design cycle and it's taking longer to close an order.

And what we're really tracking, or anxious to track, as Gary mentioned, renewals and then the repeat buying, because buying furniture is sometimes an event, and what happens, does it create loyalty? Or what happens with those things? So we continue to monitor those. We're still in the first year of the program, so not ready to really speak any of those yet.

Okay. Fair enough. Thank you.

Budd Bugatch, Raymond James.

Good afternoon, this is Bobby filling in for Budd, I appreciate you guys taking my questions. I just had two quick clarification questions, one on the Modern rollout, and the traditional galleries. Can you give us an update on how many that furniture's has been rolled out in? And when do you expect that rollout to be complete?

Sure. That effort got completed at the latter part of Q3, so at the end of October, all of the legacy galleries, save about a handful of who are transitioning to big stores next year, got the Modern product and got Design Ateliers.

So all of that's complete. And then for the lift, though, the lift is where you're referring that it's coming at a slower pace? Or it's just six to eight weeks like you saw in New York?

We think it will take six to eight weeks to ramp up. And then the other thing is we would expect in the first quarter of next year to get another lift when we mail the Modern book, right? So we will mail the second mailing of Modern in the first quarter of next year. The stores will be set with Modern. The current customer base will get exposure to Modern, and that will start to lift, and then we'd expect another lift when the book drops in the first quarter.

Okay. Then also Gary, you've talked about a lot of the changes that have gone through the business over this year and last year, and I understand you're always going to be innovating and I do agree that's the way to stay ahead in a changing retail environment. But when you look at the size of change that we had to undertake this year, especially with the new product offerings, what's a more normalized cadence that you would look to refresh a book or reshoot the book on the core product line? Is it once every 24 months or is it once every 36 that we should think about, when think about a much more longer term strategy picture?

You mean what's the life span of a product in our business? Is that what you're asking?

Yes, that's what I'm trying to get to. Has that changed drastically?

No, the way to think about it, a life span of a product in our business is on the low end, if we really miss, it's a year to two years. There's a good majority of our business that the life span is 7 to 20 years, right? So some of our best sellers have been in the assortment for a very long time. And if you look at our assortment, the core part of it is still here. We've been expanding the assortment. We just went through some significant SKU [rationalizations] where we expanded the assortment in places that the productivity didn't warrant, whether it was sizes, it might have been finishes, things like that, or a few collections.

It's not so much that collections are going away. It's within the collections, how do we optimize the offering, where we thought maybe an additional size or additional finish and color might have been more incremental than we thought, and it wound up being just sales transfer, right? So that's where the majority of the SKU rationalization is happening, and where we're being the most aggressive.

Okay, I appreciate the color. Best of luck in the fourth quarter and going into next fiscal year.

Okay. Thank you.

Oliver Wintermantel, Evercore ISI.

Good evening. I had a clarification question regarding the one-time cost in 2016. If I got all the numbers right, I think it's now about $0.70 to $0.75 and it was $0.90 to $1.00. Maybe that's for Karen, can you maybe walk us through what's different and what bucket has changed? Thank you.

Sure, so it's actually $0.95 to $1.00, so it was $0.90 to $0.94. We're just providing clarity, and the buckets have changed a little bit. The customer accommodations related to the RH Modern production delays, that stayed exactly the same at $0.30. The SKU rationalization has increased a bit as we talked about going a little bit more aggressive, and having higher penetration of those sales during this time period, that's at a $0.40 to $0.45 range. And then the last one is the Grey Card or RH membership deferral is about $0.25 now. So that's how you get to that $0.95 to $1.00.

Got it, thank you, that's helpful. And just quickly on RH Modern in stock levels, are we back to a hundred or maybe some details there please?

Yes, you never get to a 100%, so we're running at about 90% right now in stock on Modern.

But we're fully recovered, the vendors are -- (multiple speakers) -- everything is back to where -- .

Yes, 90% is a good number in our industry.

Right, the question was with the vendors, if that was sorted out from the issues that we had at the beginning of the year.

Yes, we're all caught up at every vendor.

Great. Thanks very much.

Michael Lasser, UBS.

Hello, this is actually Atul Maheshwari filling in for Michael Lasser, thanks a lot for taking our questions. My first question relates to your Grey Card membership. You mentioned in the video that your Grey Card members account for 90% of your core sales. [As] you mean 80% of your (inaudible) sales are core and dividing that by a total number of members, we're getting a $1,500 spend per member. Is that the right way to think about it?

(Laughter) We don't comment on average order, but yes -- .

Can you say the numbers again?

We can't really guide you to think about something that we don't guide.

I didn't actually hear the number.

I said $1,500 spend per member.

We don't comment on average orders or how to think about it.

Okay, that's fair. Looking into next year, you're modeling pretty significant acceleration in your comp. So what's going to drive that acceleration? Is it going to be more member signups or simply more spend per member?

Well, the biggest things are having books, so this year is very depressed as Gary has been talking about, we haven't had a source book. So that would be more of a comp driver. Certainly in the new stores it's going to have an impact, but certainly that's a comp driver.

And I think about the books as not just the books marketing the current assortment, but the books have newness. So there's new collections that also drives sales lift, right?

Okay. Thank you very much.

Matt McClintock, Barclays.

Hello, good afternoon, everyone. Two questions, the first one is, Gary, I understand that the books are what potentially going to be driving a comp acceleration, but can you speak to the historical correlation between your sales and your business and stock market, particularly as we may be looking at one of the biggest corporate tax rate cuts in history?

Yes, well, we've generally, again, don't take this year, right, because everything's moving, books are moving, promotional membership. Historically in a more normalized year, the two biggest correlations in our business is the high end housing market, not the housing market, right? So if you look at the broad housing market right now, the numbers look good. If you look at the housing market at houses a million dollars and over, it's down about 5 points against the rest of the market, so it doesn't look very good.

So we think there is a headwind in high end housing, but that doesn't really get reported broadly, so a lot of times people get mixed up, because we're an outlier in where we compete in the market, I think people miss that. Then the other one is, as you were saying, is the performance of the stock market has historically, our business has tracked with that as another indicator. So those are two of the most important things we look at.

Okay. Helpful. And secondly, I know that Modern is building, but can you potentially talk to any variances in the acceptance of the aesthetic across the country that you're seeing?

We'll know a lot more as we as we now see, as we get a couple of months, as we get into the third month of the set, I look at it and I go, we've got November, December, January. January, February we'll have a much better sense for how Modern's performing and where it's performing. The initial books that we mailed, we targeted a lot of the mailing into markets that we thought would have better response to Modern. So the first time we mailed the book, big targeted mailings into New York, Miami, San Francisco, Los Angeles, Chicago, key markets that were more urban based that we thought were more progressive markets. And so as we mail the second mailing, now that we've got a representation of Modern, we will support those markets more from a marketing point of view. So I think we'll get a much better read than our first mailing from a market acceptance point of view.

But our expectation, it's not going to respond democratically across the country. Not many of our products do. For example, one of our by far best selling bedroom collections in the company is mediocre in Los Angeles, right? And so there are different aesthetic differences in the markets, and that's why we only gave about a third of the square footage to Modern; and our sense is that we will put it out there, we will get reads, and based on the market reads, we'll flex up Modern in local markets based on acceptance and based where we think we have the positive arbitrage, and we will flex it down if we don't have acceptance. So still more to learn, very early stages of Modern.

Thanks for that color, Gary.

Jessica Mace, Instinet.

Hello, thank you. My question is on your outlet strategy. You mentioned the opening of some temporary locations, which I assume is related to the SKU rationalization. But any other thoughts you can give us on how you view the role of outlet stores going forward?

Yes, outlet for us is really just a liquidation channel, first and foremost for what we call second quality, nick and dent type items that come back from a return or an exchange. So if something gets damaged in transit, it goes to the outlet. We did open up a number of temporary outlet locations to get us through the inventory SKU rationalization and inventory efforts just to make sure we could get rid of the occupancy and avoid occupancy. So a lot of the locations, 8 of the 12 that we're going to open this year are temporary. So anywhere from 12 to 24 months and we'll be out of those. So you'll see some closures next year, as those cycle and meet their 12 or 18 month time frame.

Understood, thanks. And then my second question, you mentioned some of the headwinds facing the luxury consumer, and you mentioned some softness, relative softness at the high end of the housing market. Have you seen that change as you -- I know there's moving pieces in your business that are affecting the beginning of the fourth quarter, but anything you can call out as how that's progressed? Thank you.

The high end of the housing market has gotten slower, and that's more of a headwind that we're cycling -- if you look at the index against luxury brands, the numbers are still slow. But they're historically better year over year, right, so you're going up against the biggest difficulties. I think it's going to be interesting, as we come up against January, right, we came up -- January of last year, obviously everyone knows with the big drag down in the markets, and so we haven't factored in much upside based on that, because we just factored our business as a run rate. But that's the best we could tell today, and the two data points. So it looks like the housing market at the high end is a little slower, and it looks like there's starting to be some recovery with the luxury apparel players.

And I would now like to turn the call back to Gary Friedman for any closing remarks.

Yes, well thank you, everyone. We want to wish everyone a very happy holiday, and look forward to talking to you in the near future, and excited about 2017 as we look forward. We think it's going to be an excellent year. Thank you so much.

Ladies and gentlemen, this does conclude today's conference call. We thank you for your participation, and you may now disconnect.